A production possibility frontier shows the maximum potential level of output for two goods or services that an economy can achieve when all of its resources are fully and efficiently employed, given the level of technology available. It can be used to illustrate scarcity and opportunity cost.
The diagram shows the production possibility frontier of an economy with capital and consumer goods. Initially, the economy is at point Z. To increase the production of capital goods, by 20 units, and move to point W, there is an opportunity cost of 30 units of consumer goods.
The movement from Z to W increases the rate of economic growth, since capital goods are crucial for increasing production. Economic growth can be shown by an outward shift of the PPF. However, the loss of 30 units of consumer goods means that current living standards will fall in order to enable future living standards to rise at a faster rate.
If the economy is located at any point on it’s PPF, there is an efficient allocation of resources, since none are being wasted. However, if the economy is located within its PPF, there is an inefficient allocation of resources as not all are being used. At position U it is possible to increase production of both consumer goods and capital goods by utilising unemployed resources. Since nothing is given up in return, there is no opportunity cost.
The shape of production possibility frontiers
A typical production possibility frontier is bowed to the origin and shows that, as more of one good is produced, an increasing amount of the other is forgone – the opportunity cost rises. This is because not all resources are as efficient at other resources in the production of both goods. Diminishing returns set in.
A good example is the use of agricultural land in East Anglia and southwest England. We can assume that farm land is used for either growing wheat or for livestock production. East Anglia has highly fertile and light soil with suitable rainfall for growing wheat. Output per acre is very high. However, as we move towards the southwest, the soil becomes too heavy, and the rainfall becomes too high for growing wheat. Instead, livestock farming is far more productive per acre. If farmland in the southwest was converted to wheat production, yields would be very low, and at a cost of forgoing considerable livestock output.
Shifts in the production possibility frontier
A country’s production potential may shift over time, which is shown in the diagram by and outward shift in it’s production possibility frontier. This represents economic growth and there are a number of possible causes: for example, an increase in the quantity or quality or resources, the expansion of further and higher education and government training scheme; or an increase in investment and development of new technology.
Occasionally, the production possibility frontier may shift inwards towards the origin, indicating a decrease in the potential output of an economy. This may be caused by war or a natural disaster where many resources are destroyed. In 2004 the Thailand tsunami devastated tourism and agriculture in some coastal areas of Thailand, reducing it’s productive capacity.